Wood and another v Holden (Inspector of Taxes)
2005 [EWHC] 547
High Court Chd

This case concerns a complicated UK CGT avoidance scheme that involved the insertion of a Dutch company ‘Eulalia’ into a structure designed to bypass the UK equivalent of Section 590 TCA97. However, the key point from an Irish perspective was that the Special Commissioners had considered that the Dutch company was actually UK resident.

The High Court has now reversed the Special Commissioners’ decision on the basis that it was unclear whether the Special Commissioners applied the correct test and in any case their decision was not compatible with a correct application of the law to the facts of the case.

Park J reiterated that the basic test is the ‘central management and control’ test. In de Beers Consolidated Mines Ltd v Howe [1906] AC 455 Lord Loreburn stated, “… the principle that a company resides for purposes of income tax where its real business is carried on. … I regard that as the true rule, and the real business is carried on where the central control and management actually abides.” Park J indicated that ‘in all normal cases’ central control and management is normally associated with the board of directors but that it is possible for a company to be resident in one territory if it does not hold directors’ meetings there. While he stated, “the authority always cited for that proposition is the House of Lords decision in Unit Construction Co Ltd v Bullock [1960] AC 455”, Park J opined that, “it is also in my view a highly exceptional case in terms of the result. It was not a case where the local boards still exercised central management and control but did so under guidance and influence from the parent company in the United Kingdom. It was a case in which the local boards stood aside altogether, and the parent company effectively usurped what in theory were the functions of the local boards.”

Park J went on to consider the relationship between parent companies and their subsidiaries noting, “It is to be expected that the parent company will have plans for what it wants its subsidiaries to do, and that the directors of the subsidiaries will ordinarily be willing to go along with the parent company’s wishes. If in those circumstances the subsidiaries were resident for tax purposes wherever the parent company is resident the consequences would, in my view, be unsatisfactory… There is a difference between, on the one hand, exercising management and control and, on the other hand, being able to influence those who exercise management and control. There is another difference … between, on the one hand, usurping the power of a local board to take decisions concerning the company and, on the other hand, ensuring that the local board knows what the parent company desires the decisions to be.” It was appreciated that while the old cases related to active businesses it is common in modern times for companies (‘special purpose vehicles’) to be established with limited functions to perform. Such companies “can and do fulfil important functions within international groups, and they are principals, not mere nominees or agents … They usually have board meetings in the jurisdictions in which they are believed to be resident, but the meetings may not be frequent or lengthy. The reason why not is that in many cases the things which such companies do, though important, tend not to involve much positive outward activity.”

The judge considered other cases where some of the above aspects were considered. In one case the board of directors of a Jersey company met in Bermuda. The Special Commissioners noted that while all requests for loans were accepted, any improper or unreasonable requests would have been refused. They observed that, “although a board might do what it was told to do, it did not follow that the control and management lay with another, so long as the board exercised its discretion when coming to its decisions and would have refused to carry out an improper or unwise transaction”. Park J noted that in all these cases local management responded to proposals or instructions, the companies were established in the confident expectation that the proposals would be implemented, the functions of the companies did not involve much regular activity and there was no great need for frequent exercises of management and control. In all these cases Unit Construction v Bullock was distinguished.

Park J held that the only tenable conclusion was that under common law Eulalia was resident in the Netherlands.

In arriving at this conclusion, Park J did not accept that meetings approving transactions could be dismissed as ‘immaterial legal formalities’. He queried the relevance of the Special Commissioners’ observation that the company did little other than holding shares. It was noted “what Eulalia did was a big transaction in terms of the amounts involved, but if it did not require frequent or intensive control and management, and if all the evidence that there is shows that such decisions as were needed were made in the Netherlands, the conclusion must surely be that the company was resident in the Netherlands”. Park J found it extraordinary that once the Special Commissioners had decided that the only acts of management and control were the making of board resolutions and the execution of documents in accordance with those resolutions, they did not conclude that the company was resident in the Netherlands, where all of those acts of management and control took place.

Much had been made of the fact that the Dutch managers of Eulalia had simply followed instructions but Park J indicated that “it seems to me to ignore the realistic recognition in the authorities that, when companies are established in overseas jurisdictions in order to carry through some element in a wider scheme or business structure the idea for which originated with the parent company their directors customarily do fall in with the overall plan; but the companies do not thereby fail to be resident in their own jurisdiction.” . He was also dismissive of suggestions that because the Dutch managers could have been better briefed, their decisions were somehow not made in the Netherlands.

Park J felt that the Inland Revenue failed to produce any positive evidence that central management and control of Eulalia resided in the UK. The Special Commissioners themselves failed to identify a particular location at which central management and control was exercised; their decision incorrectly referred to London. On the other hand, the company had produced substantial evidence supporting its claim for Dutch residence including a certificate from the Dutch Revenue authorities. Park J considered that the taxpayers had satisfied the required burden of proof. He also concluded that the application of the treaty tie-breaker in conjunction with section 249 UK FA 1994 provided a statutory basis for Eulalia being regarded as resident in the Netherlands in the event that such a conclusion could not be sustained under common law.

This decision will be of significant interest in Ireland. The consideration of the ‘central management and control’ test, in the context of special purpose companies, represents a welcome modern clarification of the application of the law to such companies. Assuming the decision is not overturned by a higher court; ‘non-resident’ companies may be better armed to fend off ‘residence challenges’ by the Irish Revenue in the future.